INVESTING IDEAS NEWSLETTER

Investing Ideas Updates:

• CAG: Consumer Staples sector head Rob Campagnino says the big news in his sector this week was overall weakness caused by disappointing earnings from Procter & Gamble (PG).  Campagnino points to an important market effect: PG has a 14% weighting in the XLP, the primary consumer staples sector ETF.  Says Campagnino, “We think PG is an interesting contrast with ConAgra, our preferred name in the staples sector.  Unlike PG, we believe CAG has a clear path to earnings upside based on declining raw materials costs and merger synergies.  Using the valuation approach he employs, Campagnino says “it was difficult for us to support PG’s stock price prior to the earnings release.”  By contrast, “We believe CAG is one of the few staples names where we can still make a compelling valuation case.” (Please click here to see the latest Stock Report on CAG.)

• HOLX: Health Care sector head Tom Tobin’s downbeat read on the first quarter proved on target, as “generally soft utilization” showed up in weak earnings reports from a host of companies in this space. Hologic’s stock price has suffered along with the rest.  But Tobin expects “a solid number of surprises to the upside” from HOLX’ launch of their Tomosynthesis mammography system.  And expectations for US medical consumption continue positive, with Tobin looking for upside surprises through the rest of the year, especially springboarding off a bearish reaction to the first quarter.  Tobin’s Increased Birth Rate thesis remains strongly in force.  That, coupled with rebounding Consumer strength and increasing employment, provides a strong set-up for increased health care consumption. (Please click here to see the latest Stock Report on HOLX.)

• DRI: Restaurants sector head Howard Penney says earnings in his sector confirm Hedgeye’s “Strong Dollar/Strong Consumer” Macro theme.  Overall, the restaurant space is performing well – except for poorly managed companies like Darden Restaurants.  So, in a strong earnings season, why would you remain invested in a stock like DRI?  Penney says the strong consumer environment is benefitting DRI as well, while broad mismanagement of the company’s various brands is increasingly likely to create action, whether by dissident shareholders, or by a muscular outsider.  And then there’s that 4% yield – more than twice what you get on 10-Year Treasurys. (Please click here to see the latest Stock Report on DRI.)

• FDX: Industrials sector head Jay Van Sciver sees confirmation of his Long thesis as Federal Expresswins full renewal of its airlift contract with the US Postal Service.  This apparently caught some on Wall Street by surprise – Van Sciver believes recent analyst downgrades probably anticipated FDX losing the business to UPS.  But even the federal government can make the occasional smart decision.  As our grandpa used to say “A stopped clock is right twice a day!”  The USPS has a strong union; Van Sciver believes there is still bad blood over clashes with UPS in the 1980’s and 1990’s, making renewal of theFDX contract less controversial.  And government contracts have a high inertia quotient; FDX was doing a competent job of servicing the USPS, and even the government knows “if it ain’t broke, don’t fix it.”  Van Sciver says the price of FDX shares remains unrealistically low.  The valuation seems to only reflect the company’s Ground and Freight business.  Van Sciver says this gives shareholders the equivalent of “a free option on the success of the FedEx Express restructuring.” (Please click here to see the latest Stock Report on FDX.)

• MPEL – Melco Crown Entertainment remains Gaming, Lodging & Leisure sector head Todd Jordan’s favorite name “with the catalyst of a terrific Q1 earnings release looming.”  Jordan shared his projections this week, looking for $1.119MM of net revenue – 3% above Wall Street consensus projections – and $267MM of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization, a widely-used measure of basic operational profitability of a company) – 5% ahead of consensus.  Jordan says “another strong quarter should bring the company closer to gaining the respect that it deserves from the investment community.”  Jordan looks for MPEL to “transition from a trading vehicle to a core long-term holding” for large institutional holders, adding a further boost to multiple expansion. (Please click here to see the latest Stock Report on MPEL.)

• WWW: Wolverine World Wide is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the preailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns. (Please note that we will issue a full Stock Report on WWW on Monday.)

Macro Theme of the Week: The Consumer

The Dollar is back, in case you haven’t heard, and now that people are waking up to strength in The Buck, it is changing their investing outlook. 

This week’s GDP report was “a disappointment,” as the economy grew 2.5% in the first quarter, less than the 2.8% expected by economists.  There are plenty of problems around this scenario (see this week’s Investment Term, below: “Leading Economic Indicators.”)  Senior US Macro analyst Christian Drake unpacks the good news.  The Consumer portion of GDP came in much stronger than expected – what an economist would probably call an “upside disappointment” – along with strength in housing and construction.  With the Sequester in force, the Government spending portion of GDP was down substantially.  As we have said, we think any reduction in government spending is good for the Dollar.

Senior Macro analyst Darius Dale delivered an important presentation this week on the disarray in emerging markets.  A key takeaway of Dale’s analysis is that US investors fled Dollar-denominated assets during the Financial Crisis.  They overlooked such issues as government corruption, lack of national infrastructure, lack of developed financial markets and lack of press freedom in their rush to invest in countries linked to commodities.  Whether in Russia (oil), Brazil (oil, iron ore), India (cheap labor) or China (massive growth driven by sheer numbers), the BRICS characterized this appetite for investing with a very narrow focus. 

The Fed’s intervening policy (both chronologically and monetarily) to weaken the dollar worked to attract investment in financial assets.  Now, as renewed Dollar strength deflates the global commodities bubble, investors are taking a second look at emerging markets using more standard analytical metrics and finding – Whoa! Smack myself on the forehead! – many of these markets and companies don’t have financial depth, often have weak managements hopelessly tied to a conflicted political process, or are simply running on promises that have never been fulfilled.

Europe, which is supposed to have more “first world” economic features, is really a decentralized collection of markets.  They have a single currency, and even a central bank.  But they don’t have single securities market or a single market regulator.  Nor a single economic policy.  It seems they put the Euro before the horse.  After decades of European self-experimentation, it is clear that a common currency should be the result of harmonized economic policy, not the cause. 

The Dollar is back?  It never left.  Dale’s analysis indicates the Dollar is the long-term – and exceptionally powerful – tail wagging the dog of global investment: ultimately, investment in Emerging Markets was driven by fear over Dollar-denominated assets, not by intrinsic attractiveness of those markets.  Now that the Dollar is flexing its biceps, aren’t you glad you don’t have a pocket full of… well, anything else?

Global indicators of economic activity look poor indeed,  Meanwhile, here at home Consumers are Consuming like it’s going out of style.  With over 70% of GDP growth in America driven by the Consumer, this has massive implications.

Spend It If You Got It: Christian Drake says Real Weekly Earnings growth is positive – “a rarity over the last three years” – and sees continued improvement in Housing and Employment.  Financials sector head Josh Steiner says consumers’ ability to spend is increasingly solid.  “Both Seasonally-Adjusted and Non-Seasonally-Adjusted initial unemployment claims posted sharp improvement,” providing the best leading indicator for credit card delinquencies.  Earnings at credit card companies were better than expected in the first quarter, and the Unemployment data suggests continued strength. 

We have seen a major shift in credit as the “perpetually long-term unemployed” segment of the population are now “non-underwriteable.”  Translation: solid citizens only, please.  There will not be another wave of subprime lending any time soon. 

(Over time, of course, there will be another disaster brought on by inexcusable, fraudulent credit practices.  It will likely not happen very soon, though Steiner says the new, more stringent lending standards have already led banks to reduce their reserves against delinquencies.  The brilliant economist Hyman Minsky – a favorite of Wall Street cynics – demonstrated how our market system rides on boom-to-bust cycles like a three-year-old on a tricycle.  Pedaling faster and faster, shrieking with delight, and always happiest just before he crashes into a tree.)

Housing: New Home Sales rose 18.5% over March 2012 to 417,000 units, and Median Home Prices rose 11.8%, the fastest growth rate since November 2005.  Steiner says new home sales could double from current levels.  New household formation rates imply a need for about 2 million new housing units this year – but only one million are scheduled to be built.  And remember that the decline in construction had a ripple effect: as builders stopped building, materials suppliers stopped manufacturing nails, shingles, windows and 2X4s.  We are still far from the ramp-up required to re-start the construction cycle, leaving plenty of room for near-term economic expansion.

The labor market continues to improve.  Even if the reporting is congested by government fiddling with a mass of opaque statistics (Unemployed, Under-employed, Part-Time employed, No Longer Seeking Employment...) labor metrics continue in the right direction, another positive data point for housing in particular, and for consumption in general. 

Finally, Drake and Steiner remind us that Hedgeye views Housing as a Giffen Good, the economic notion of something that becomes more sought after the higher it goes in price.  Not everyone agrees with our position.  But if this doesn’t make sense to you, we suggest you contemplate the routine phenomenon of panic buying in the stock market.  Steiner says housing behaves largely the same way.  And as we pointed out last week, for the first time since before the 2008 financial crisis, the value of your house and of your stock portfolio have both gone up.

Sizing It Up: Hedgeye CEO and Macro sector head Keith McCullough identifies bullish market formations on a range of popular ETFs relating to US consumption.

• US Dollar (UUP)
• S&P 500 (SPY)
• US Consumer Discretionary (XLY)
• US Consumer Staples (XLP)
• US Healthcare (XLV)

He also notes bullish formations in consumer bellwether stocks Starbucks (SBUX) and Nike (NKE).

Offsetting these formations – and looking decidedly bearish on all three of Hedgeye’s proprietary risk management durations TRADE, TREND, TAIL.

• Commodities (CRB Index)
• Gold and Gold Miners (SLV and JJC)
• Japanese Yen (FXY)
• Basic Materials (XLB)
• Energy (XLE)
• Russia (RSX)
• Brazil (EWZ)

Says McCullough, “the big thing about Big Things in Macro is that they can last.”  It’s too early to tell whether we are riding an extended blip, or the beginning of a long-term secular trend.  To keep our Risk Management finger on the pulse of the US consumer, Hedegeye will continue to ask three big questions:

1)     What can stop the US Dollar from going up?

2)     What can stop the Euro and the Yen from going down?

3)     What can stop the commodities bubble from popping?

We remind our readers that ETF trading can be confusing and has its own unique risks.  Consult your investment professional before you dive in. 

We’re watching the global markets.  See you next week – by which time all this could be dramatically different.

Welcome to our world.

Sector Spotlight: Consumer Staples

Consumer Staples sector head Rob Campagnino wrote last week “Every earnings season has its own ‘feel’ and the early read on consumer staples earnings reports is that so long as the report isn’t a complete disaster, the momentum behind the stock (and the sector) is likely to continue.”  Campagnino sees money continuing to flow into the sector for a variety of basic reasons, including low volatility and high yield among major stocks in the group.

The deflating of the global commodity bubble could provide a boost to these stocks.  To name one key input, Campagnino likes the odds of corn prices continuing to decline.  Good for companies like CAG that produce basic food ingredients, and great for companies like Coke (KO) that sell sugared drinks. 

There’s also the comfort level – the perceived safety of investing in names you know well.  Coca Cola (KO) – it’s more reliable than water (actually true: in most of the world it is safer to drink, and there are places where it is in more plentiful supply.)  Dr. Pepper (DPS) – “comfort food” names include Hawaiian Punch and Snapple.  Procter & Gamble, Hershey’s, Rubbermaid… these are the names you grew up with. 

With many of these companies yielding more than the 10-year Treasury, the sector looks like a reasonably safe place to mark time with one’s investment cash.  Meanwhile, if Hedgeye is right on the related trends we have identified – Strong Dollar/Deflating Commodity Prices/Consumer Spending – it could turn out to be a boost to the overall sector.

Investment Term: Leading Economic Indicators

Wall Street indexes predicted nine out of the last five recessions.

-         Paul Samuelson

 

You might expect something called “Leading” to be really important.  Or you might expect it to have a lot of followers.  In fact, what economists call “Leading Indicators” are often more important as contributors to economic theories than they are as actual predictors of what is about to happen.

Professor Samuelson was the first American to win the first Nobel Prize in Economics.  As you can tell from the above quote, he was an academic, but with a clear understanding of how the real world operates.

Economic Indicators should really be called “Economists’ Indicators,” since they are numbers the economists trot out as justification for policy recommendations.  And “Leading,” as in a lawyer objecting to “leading the witness,” since economists increasingly see their primary responsibility as retaining their government jobs, rather than plunging into the complexities of their métier.  

This is what it has come to: politicians we elect to make leadership decisions defer their decision-making to academics – whose whole job is to stare at the wall and theorize.  Fed Chairman Ben Bernanke is a highly respected academic.  But running a meeting of the Board of Fed Governors is not the same as running a corporation.  Or even a plumbing-supply company or an auto body shop.  Nor is it adequate training for running a country.  Don’t get us started….

One of the big numbers that came out this week was Durable Goods Orders.  This number can be hard to read, and the reported decline of 5.7% from the prior month does not necessarily mean we should sell all our stocks and run for cover.

“Durable goods” are expensive manufactured goods – “big-ticket items” they’re called – generally designed to last three years or longer.  It says a lot about our society’s frame of reference that 3 years is considered “durable,” since this term also applies to such notions as religion, marriage, and the Constitution.

Teasing this month’s report apart, orders for civilian aircraft and defense goods were down.  But these are among the most expensive and most volatile components of the statistical mix under the best of circumstances.  With the Sequester haunting the halls of Washington, defense spending fell by more than 33%.

Hidden within the overall decline, demand for electronics and for computers rose in the month, and demand for motor vehicles and parts rose slightly.  We read this as Consumption follow-through which, while not overly robust, continues to move in the right direction. 

We expect Consumption to continue to strengthen in the near term – which is not to say it will be without any ups and downs.  That, as our dear old dad used to say, is what makes horse racing.

And stock markets.